Digital Currency: An International Legal and Regulatory Compliance Guide

Digital currency systems make use of cryptographically secure distributed computing networks to exchange economic value and support a growing array of applications. The nature of these computing platforms and the scope of their applications raise important legal compliance issues. Many jurisdictions around the world are examining the extent to which digital currency systems are affected by existing laws and regulations, and the extent to which those existing laws should be modified or new laws enacted to address the growth of digital currencies. It is already clear, however, that a variety of laws and regulation in virtually every jurisdiction are already applicable to digital currency and its applications. In this environment, developers, distributors, and users of digital currency and associated systems already face substantial legal compliance issues. Understanding these current and potential legal compliance requirements is essential for successful use of digital currency platforms and their applications.

National governments apply well-established rules addressing the creation and use of fiat currency used in their countries. Fiat currency is often also described as a nation’s legal tender. It is the national currency, issued and guaranteed by the national government. At present, no nation has established any form of digital currency as its sole form of fiat currency. For this reason, traditional laws governing currency have not been directly applicable to Bitcoin and other virtual currencies.

National authorities regulating currency generally do not have direct jurisdiction over virtual currencies, to date, as they are not national fiat currencies. However, currency regulators are influencing development of digital currency in several key indirect ways. Through their authority to protect the value and integrity of national fiat currencies, they take actions affecting digital currencies claiming that such actions are necessary to protect their national currency. Additionally, as these regulators generally have the authority to control the activities of banks and other key financial institutions, they influence digital currency development and use by restricting the ability of those institutions to use or accept virtual currency. Currency regulators commonly have jurisdiction over conversion of foreign currency, and through this role, they now routinely restrict the ability of parties to conduct conversions between digital currencies and traditional national currencies. National currency regulators have also issued substantial warnings to consumers of the risks associated with digital currency use. Currency regulators often have authority over funds transmission and money transfers, and they frequently exercise that jurisdiction in the context of virtual currency use. Some government are now exploring the possibility of government controlled digital currency and of government participation in the blockchain of existing virtual currency platforms.

Laws and regulations directed against money laundering are some of the most active legal compliance obligations facing the virtual currency community globally. Authorities fear use of digital currencies for money laundering and for direct financing of illegal conduct due in large part to the largely anonymous and international nature of virtual currency systems. In most jurisdictions, existing rules against money laundering have either been interpreted to address digital currencies or are being specifically modified to provide expressly such coverage. Anti-money laundering requirements are most frequently presented in the form of “know your customer” requirements, transaction monitoring obligations, and mandatory reporting rules. These requirements are most commonly applied to “money services businesses” which include banks and other financial institutions as well as money transmitters, money transfer services, and exchange trading and conversion service providers. Anti-money laundering laws and regulations present some of the most significant current legal compliance obligations facing the virtual currency community around the world.

In many jurisdictions, virtual currencies are, at least in some contexts, viewed to be a commodity, a form of property. Classification of digital currency as property has substantial and far-reaching legal consequences. Digital currencies are now traded through trading exchanges. Future contracts and other forms of financial derivatives based upon virtual currencies are also bought and sold in marketplaces. Enterprises such as LedgerX and TerraExchange are now seeking full regulatory approval to permit them to function as authorized trading exchanges able to serve as trading markets for a wide range of financial products. Recognition of digital currencies as property has profound tax consequences. It makes digital currency potentially subject to the laws of debtor/creditor relations when the currency is held as an asset. Digital currency as property is subject to diverse laws including laws of wills, estates, and trusts, when the currency is part of an individual’s personal estate. Laws and international treaties governing foreign investment in assets are in some cases applicable to trans-border purchase of virtual currency. Digital currency is already widely viewed to be a form of property in many jurisdictions, and in that capacity, it is currently potentially subject to a substantial and diverse set of rules addressing property ownership and transfer.

Digital currency platforms are now in use to process trades involving virtual currencies and other financial products. Enterprises such as LedgerX and TeraExchange are now seeking full regulatory approval to use the cryptographically-based distributed computer networks pioneered by digital currency systems for use to support financial trading exchanges and markets. These systems will be subject to full regulatory oversight, as our existing traditional financial markets. The key capabilities of the digital currency platforms include security, transaction history transparency, and cost efficiency. Those characteristics can make valuable contributions to the future success of financial markets.

Virtual currencies are bought and sold in digital markets in the same manner as other goods, subject to traditional laws governing contracts, commercial sales, and consumer protection. Those currencies are also used as the basis for financial products including future contracts and other financial derivatives. When digital currency is traded as a financial product and when digital currency platforms are used to create and operate financial markets, the currency and its platforms are subject to the oversight of financial regulators. This dual nature of legal compliance associated with virtual currency and its platforms is essential. Under these circumstances, digital currency systems and activities face different legal compliance challenges depending on their specific functions. Understanding this environment is essential for effective legal compliance in the virtual currency community.

Securities are a range of financial instruments including stocks, bonds, and derivatives. They represent funding provided by investors to enable third parties to operate businesses for profit. Owners of securities do not perform the work of operating the business, but instead provide funds necessary for the business and receive financial return from the business for their investment. Securities are governed by an active and extensive set of regulations around the world. Under some circumstances, virtual currencies fall within the regulatory oversight of securities regulators. The primary goal of securities regulation is protection of the integrity of the investments and markets associated with all securities.

Digital currency can be applied in ways that subject the currency to regulatory oversight as financial securities. Digital currency platforms can be used to support and operate electronic trading exchanges for the sale and purchase of financial securities. This dual nature of virtual currency systems subjects those systems to multiple levels of regulatory oversight. To the extent that digital currency is used as a security, it is subject to traditional securities regulation. When virtual currency platforms operate to enable securities trading, they are subject to regulatory oversight as securities trading exchanges. The dual nature of digital currency systems substantially increases the scope and complexity of legal compliance efforts.

Securities regulators around the world are examining the extent to which digital currency activities and platforms are within the scope of their jurisdiction. Most regulators take the position that the extent of their oversight authority is entirely dependent on the actual functional activities of the digital currency system operations. In some jurisdictions, digital currency operations deemed to be electronic services or financial product offerings are subject to oversight. Key participants in the virtual currency community, such as Overstock.com and LedgerX, are increasingly taking the position that they will pursue full compliance with existing regulatory requirements to the extent that their digital currency operations fall within the scope of existing regulation. This approach is prudent and likely to facilitate growth of the virtual currency market. The approach does, however, require extensive legal compliance activity.

An increasing number of jurisdictions, such as New York, California, and the Isle of Man are developing legal initiatives specifically directed toward digital currency. Many other jurisdictions are modifying their existing laws to more clearly and specifically address digital currency and its applications. Even in jurisdictions where such initiatives are not underway, digital currency is already subject to an extensive and complex set of legal compliance obligations established by existing laws, including contract, commercial transactions, criminal, property, and consumer protection requirements. Virtually every category of law already has influence over virtual currencies and their use. Legal compliance efforts are already necessary for all members of the digital currency community, ranging from casual users all the way through the more active members of the global virtual currency community. In the world of digital currency, legal compliance is a vital and complicated challenge which is already present and demands immediate attention.